Topsy-Turvy Market: A Window of Opportunity
Topsy-Turvy Market: A Window of Opportunity
Richard Knop, Boles Knop & Co.
By Nick Wakeman, Staff Writer
Global market turmoil is not dampening merger and acquisition activity in the government information technology sector as chief executives of these firms seize buying and selling opportunities to satisfy their growth and cash needs.
With the initial public offering and debt markets disappearing, companies that need cash have two alternatives: sell out or stick with internal growth, said John Rexrode, senior vice president of corporate development for Affiliated Computer Services Inc. of Dallas.
But relying on internal growth is risky, he said, because it lowers what investors might pay, especially for small to midsize companies that lack the strong growth lines of their acquisition-happy competitors.
Rexrode's company, which bought systems integrator Computer Data Systems Inc. of Rockville, Md., last December for $373 million, has several deals in the works. "We always have a pipeline of government and commercial companies we are looking at," he said.
Other companies with visions of doing deals in the next six months include CACI International Inc., Northrop Grumman Corp., Vista Information Technologies Inc., and TRW Inc., industry officials said.
Because of market uncertainties, "there are a lot of rapidly growing companies out there that might see more risk in owning a business than they did before, and ultimately that will drive people to sell," said Phil Canfield, an associate with Golder, Thoma, Cressey, Rauner Inc., an investment firm in Chicago. "There are some real opportunities to work on getting deals done right now."
But the volatile stock market and tight debt markets are making small to midsize companies rethink their growth strategies, said Richard Knop, a partner with the investment banking firm Boles Knop & Co. of Middleburg, Va.
"The downturn in the public markets has removed [initial public offerings] as an exit strategy or as a way to finance growth," Knop said.
Douglas Schmidt, a managing director at Legg Mason Inc. of Baltimore, said he has had four prospective IPOs "push the pause button" since midsummer. One of those IPOs was for a federal IT company, he said, declining to name the company.
James Duggan, president of Vista Information Technologies of Herndon, Va., said: "People may as well forget about IPOs for awhile, unless they really have something that will dazzle the investment community, which is difficult to find these days."
The privately held company has built itself into a $100 million a year systems integrator through a roll-up strategy that has included six acquisitions during the last two years.
Some of the downward forces in the market are reminiscent of what happened in the late 1980s and early 1990s when the country went into a recession, said Jack London, chief executive of CACI of Arlington, Va. The government contractor has embarked on an aggressive acquisition strategy, but most of its deals have been companies valued at under $50 million.
CACI has nearly closed its $44.2 million deal to buy QuesTech Inc., a Falls Church, Va., software and systems engineering company. That is CACI's third deal since last fall.
"If the transactions are based on a good, solid balance sheet and have good fundamentals, I think banks are going to continue to have a significant interest," London said.
But if you are talking about larger more exotic mergers, where cash is an issue, he said, then that would be "a different animal" because of the economic situation.
Acquisitions are still a goal of TRW, which hopes to close several deals in the next six to eight months, said Philip Odeen, executive vice president and general manager of the Systems & Information Technology Group. The Cleveland-based company is mostly targeting IT services companies with strong state and local government and commercial practices. Such deals will be in the $10 million to $100 million range, he said.
Odeen noted it would be difficult in today's market to structure a merger like the one that combined TRW with his old company, BDM International Inc. of McLean, Va. That deal closed last December and was worth about $1 billion.
In September, Northrop Grumman Corp. of Los Angeles bought defense IT contractor International Research Institute Inc. of Reston, Va., for $55 million. Knop helped broker that deal.
The stock market downturn has lowered the valuations of public companies and, in turn, the value of privately held companies has gone down, said Jon Kutler, president of Quarterdeck Investment Partners of Los Angeles, a firm that brokers mergers and acquisitions.
The drying up of the senior debt market makes the larger deals very difficult to close, because that kind of financing often makes up the difference between what a bank is willing to lend and how much of its own equity a company puts up to finance a deal, Kutler said.
"The same things happened in 1988, and it really shut off [merger and acquisition] activity in the services marketplace for three to four years," he said.
But Kutler said that won't happen this time. Today, companies have a strategic reason to make acquisitions ? they need to make them to survive, he said.
So despite an uncertain stock market and a tight market for debt, consolidation will continue especially among government IT companies, Knop said.
"Government contractor consolidation is going to continue because of procurement reform and the move toward government outsourcing, both of which require companies to have larger critical mass," he said. "That activity, if anything, is going to accelerate."
The government market also is somewhat protected from the ups and downs of the rest of the economy because government contracts last several years, Schmidt said.
"On the federal side, you don't get as worried about your business falling apart," he said.
Indeed, many government contractors are avoiding the pain that their rivals with a heavy international focus are experiencing.
Gary Denman, chief executive officer of the technology services company GRC International Inc., Vienna, Va., echoed Schmidt's sentiment this week, announcing that first quarter income more than doubled to $3.1 million compared to $1.4 million one year ago.
By primarily focusing on the professional and technical services market within the Defense Department, "our business has not been affected by the recent economic turmoil that threatens technology companies serving foreign commercial markets," Denman said.